Tax-Loss Harvesting – What is the ‘January Effect,’ and Will it Soon be in Play?

In its recent filing, MicroStrategy Inc. announced that it sold 704 Bitcoin for a total of about $11.8 million, citing tax purposes. The firm subsequently bought 810 BTC two days later. As of Dec. 27, MicroStrategy held about 132,500 Bitcoin worth more than $2 billion and now sits on a massive unrealized loss of about $2 billion.

This was the first-ever sale of Bitcoin by the enterprise-software firm better known as the largest corporate buyer of Bitcoin that defied its CEO Michael Saylor’s promise of never selling any portions of its BTC stash.

“MicroStrategy plans to carry back the capital losses resulting from this transaction against previous capital gains,” the company said in its filing, adding this “may generate a tax benefit.” This shows that the firm's decision to sell bitcoins was more due to tax reasons than losing confidence in the leading cryptocurrency.

MicroStrategy became the first publicly-traded company to add Bitcoin to its balance sheet in the third quarter of 2020 and has reiterated many times that it's investing in Bitcoin for the long term.

Its head of investor relations and treasury, Shirish Jajodia, also maintained that “there is no change to our Bitcoin strategy, which is to acquire and hold Bitcoin for the long term.”

MicroStrategy's first Bitcoin sale shows what commonly occurs at the end of a year — tax loss harvesting.

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What is Tax-loss Harvesting?

Tax-loss harvesting allows investors to sell assets at a loss at the time of market downturns when losses are highest or at the end of a tax year when they can estimate their overall gains in order to reduce tax liabilities. To use tax-loss harvesting, an investor would sell investments at a loss to capitalize on market timing or the tax year.

In the US, any losses from the sales can be used to offset income tax up to $3,000 in total. The cryptocurrency capital loss can be used to offset any capital gains you realized that year — even if they came from selling another security or other property, like stock or home.

The benefits of tax-loss harvesting include reducing your tax bill, deferring taxes, and rebalancing your portfolio.

As an effective way to reduce your tax bill, if you have investments that have lost value, selling them can offset capital gains from other investments such as crypto and stocks. This can help you keep more of your investment gains, as you will only be taxed on the net gain.

Tax-loss harvesting can also help you defer taxes. If you reinvest the proceeds from the sale of your losing investments, you can defer paying taxes on the gains until you sell the reinvested assets. This can be a useful strategy if you expect your tax rate to be higher in the future.

Tax-loss harvesting can also help you rebalance your portfolio in the way that if you have investments that have gained value, selling them and reinvesting the proceeds can help you bring your portfolio back into balance. This can be especially helpful if you have a target asset allocation that you are trying to maintain.

Investors opting for the end-of-year tax-loss-harvesting strategy value efficiency and realize they get to take advantage of market trends throughout the end of the year. This perfectly legal strategy can be pretty beneficial, but it is important to note that it can also be complex and should be used in conjunction with professional tax advice.

Also, to take advantage of tax-loss harvesting, you must track your cryptocurrency holdings and transactions carefully. This can be a challenge, as there is no central repository for all cryptocurrency transactions. However, there are a number of tools and services that can help you track your holdings and transactions. Once you have a clear picture of your gains and losses, you can start to offset your losses against your gains.

With a tax-loss harvesting strategy typically employed by investors towards the end of the calendar year, this often results in an incline in the prices of assets in the new year, which creates a phenomenon called the ‘January Effect”.

What is the “January Effect”

The January effect is a phenomenon in the stock market in which stock prices tend to rise in the month of January. The effect is believed to be caused by a combination of factors, including tax-loss selling by investors in December and an influx of new money into the market in January.

This effect is also attributed to an increase in buying activity by individual investors after the holidays. The January Effect can be a beneficial phenomenon for investors who are looking to buy stocks at lower prices. Additionally, the January Effect can signal a positive outlook for the stock market for the year ahead.

While the January effect is most often seen in the U.S. stock market, it has also been observed in other markets around the world.

January Effect on Crypto

Traditionally a month of strong stock market performance, this well-documented phenomenon can also be seen in the crypto world, with prices of Bitcoin and other digital assets typically rising during the month.

Last year, Bitcoin went down in January after the crypto prices topped in November 2021. However, before that, in January 2021 and 2020, Bitcoin prices recorded an increase of 14.35% and 30%, respectively.

In 2019, BTC price went up in the first few days of January but recorded a negative 7.35% performance in the entire month. This came after Bitcoin bottomed in the prior month, Dec. 2018. This year marked the last bear market, but Bitcoin price still managed to go up in the first few days of Jan. after the markets peaked in Dec. 2017, only to end Jan. 2018 down by 25.8%.

A similar price movement can also be seen in the years before that when the price of digital assets recorded a jump in the first few days of January, which continues further in bull markets while resulting in a drawdown in bear markets.

Source: Bitcoin Monthly Return

There are several reasons why the January effect may be more pronounced in crypto than in traditional markets. First, the crypto market is still relatively young and immature and thus more prone to volatile swings.

Second, the end-of-year holiday season is a period of reduced trading activity, and prices may be artificially depressed during this time. When trading activity picks up again in January, prices may rebound accordingly.

Whatever the reason, the January effect is a real phenomenon in the crypto world. While the effect is not guaranteed to occur every year, it is something that investors should be aware of. Those who are bullish on crypto heading into the new year may want to take advantage of this effect by buying digital assets early in the month.

Where to Next?

After topping out in November 2021 at $3 trillion, the total cryptocurrency market cap has remained below the $1 trillion mark since last spring. As of writing, the total market cap is sitting around $842 billion, as per CoinGecko.

Majors like Bitcoin and Ethereum are down about 75% from their respective all-time highs (ATH). Meanwhile, the majority of altcoins have lost more than 90% of their value since their peaks.

BTC is currently trading at $16,700, but Bitcoin bull Tim Draper predicts the token to be worth $250,000 by the end of the year. “I suspect that the halvening in 2024 will have a positive run,” he said.

But it’s not all bulls, as according to Standard Chartered, Bitcoin may sink as low as $5,000. “Yields plunge along with technology shares” in Standard Chartered’s 2023 scenario, “and while the Bitcoin sell-off decelerates, the damage has been done,” it said.

So, while the market has stabilized since last year’s brutal beating, it is still difficult to predict if the crypto market has bottomed yet. We could very well see more pain ahead, or the market may enter the boring phase characterized by sideways price action.

The next couple of months in 2023 are a time of great turmoil and uncertainty for investors. Currently, the macro is the focus, and crypto assets are expected to trade in line with global risk assets over the course of the year.

What we can surely expect is that the market will continue to grow as more people become aware of cryptocurrencies and their potential. In the long term, we believe that the market will continue to rise as more people adopt cryptocurrencies to store and transfer value.